1 An Introduction to the Low-Income Housing Tax Credit Mark P. Keightley Specialist in Economics March 28, 2018 Congressional Research Service 7-5700 RS22389 An Introduction to the Low-Income Housing Tax Credit Congressional Research Service Summary The Low-Income Housing tax credit (LIHTC) program is one of the federal government s primary policy tools for encouraging the development and rehabilitation of affordable rental Housing . These nonrefundable federal Housing tax credits are awarded to developers of qualified rental projects via a competitive application process administered by state Housing finance authorities. Developers typically sell their tax credits to outside investors in exchange for equity. Selling the tax credits reduces the debt developers would otherwise have to incur and the equity they would otherwise have to contribute.
2 With lower financing costs, tax credit properties can potentially offer lower, more affordable rents. The LIHTC is estimated to cost the government an average of approximately $ billion annually. In late 2017, there was a revision to the Internal Revenue Code ( 115-97) that substantially changed the federal tax system. The revision did not directly alter the LIHTC program; however, there have been early reports of downward pressure on tax credit demand stemming from the 2017 tax revision. It is not yet clear what, if any, impact there may be on the affordable Housing supply in the long run as the result of the recent changes to the federal tax code. Most recently, the 2018 Consolidated Appropriations Act ( 115-141) made two changes to the LIHTC program. First, the act modified the so-called income test, which determines the maximum income a LIHTC tenant may have.
3 Previously, each individual tenant was required to have an income below one of two threshold options (either 50% or 60% of area median gross income , depending on an election made by the property owner). With the modification, property owners may use a third income test option that allows them to average the income of tenants when determining. Second, the act also increased the amount of credits available to states each year by for years 2018 through 2021. This report will be updated as warranted by legislative changes. An Introduction to the Low-Income Housing Tax Credit Congressional Research Service Contents Overview .. 1 Types of Credits .. 1 An Example .. 1 The Allocation Process .. 2 Federal Allocation to States .. 2 State Allocation to Developers .. 2 Developers and Investors .. 3 Recent Legislative Developments.
4 5 Contacts Author Contact Information .. 5 An Introduction to the Low-Income Housing Tax Credit Congressional Research Service 1 Overview The Low-Income Housing tax credit (LIHTC) was created by the Tax Reform Act of 1986 ( 99-514) to provide an incentive for the development and rehabilitation of affordable rental Housing . These federal Housing tax credits are awarded to developers of qualified projects via a competitive application process administered by state Housing finance authorities (HFAs). Developers either use the credits or sell them to investors to raise capital for real estate projects, which, in turn, reduces the debt or equity contribution that would otherwise be required of developers. With lower financing costs, tax credit properties can potentially expand the supply of affordable rental Housing . The LIHTC is estimated to cost the government an average of $ billion Types of Credits Two types of LIHTCs are available depending on the nature of the construction project.
5 The so-called 9% credit is generally reserved for new construction, while the so-called 4% credit is typically used for rehabilitation projects and new construction that is financed with tax-exempt bonds. 2 Each year, for 10 years, a tax credit equal to roughly 4% or 9% of a project s qualified basis (cost of construction) is claimed. The applicable credit rates have historically not actually been 4% and 9%. Instead, the credit rates have fluctuated in response to market interest movements so that the program has delivered a subsidy equal to 30% of the present value of a project s qualified basis in the case of the 4% credit, and 70% in the case of the 9% For both the 4% and 9% credit it is the subsidy levels (30% or 70%) that are explicitly specified in the Internal Revenue Code (IRC), not the credit rates. Since 1986, the 4% rate has ranged between and , and the 9% credit between and Since 2008, however, there has been a floor under the 9% credit below which the new construction credit rate cannot fall.
6 An Example A simplified example may help in understanding how the LIHTC program is intended to encourage affordable Housing development. Consider a new affordable Housing apartment complex with a qualified basis of $1 million. Since the project involves new construction it will qualify for the 9% credit and generate a stream of tax credits equal to $90,000 (9% $1 million) per year for 10 years, or $900,000 in total. Under the appropriate interest rate the present value of the $900,000 stream of tax credits should be equal to $700,000, resulting in a 70% subsidy. The 1 Computed as the average estimated tax expenditure associated with the program between 2016 and 2020. Congress, Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2016-2020, committee print, 115th Cong.
7 , 1st sess., January 30, 2017, JCX-3-17. 2 A developer using federal tax-exempt bonds can qualify for the 9% credit if they reduce the project s eligible basis by the amount of the tax-exempt bond subsidy. 3 For both the 4% and 9% credit it is the subsidy levels (30% and 70%) that are explicitly specified in the Internal Revenue Code (IRC), not the credit rates. 4 The lower bound of this range is the rate that would have prevailed in absence of the 9% credit floor. Department of the Treasury, Internal Revenue Service, Revenue Ruling 2016-18, Table 4, Appropriate Percentages Under Section 42(b)(2) for August 2016, and Novogradac & Company LLP, Appendix H: List of Monthly Credit Percentages, in Low-Income Housing Tax Credit Handbook, 2006 ed. (2006), p. 845. The 4% and 9% credits also hit these lower bounds in September, 2012.
8 An Introduction to the Low-Income Housing Tax Credit Congressional Research Service 2 subsidy is intended to incentivize the development of affordable Housing that otherwise may not be financially feasible or attractive relative to alternative investments. The situation would be similar if the project involved rehabilitated construction except the developer would be entitled to a stream of tax credits equal to $40,000 (4% $1 million) per year for 10 years, or $400,000 in total. The present value of the $400,000 stream of tax credits should be equal to $300,000, resulting in a 30% subsidy. The Allocation Process The process of allocating, awarding, and then claiming the LIHTC is complex and lengthy. The process begins at the federal level with each state receiving an annual LIHTC allocation in accordance with federal law.
9 State Housing agencies then allocate credits to developers of rental Housing according to federally required, but state created, allocation plans. The process typically ends with developers selling allocated credits to outside investors in exchange for equity. A more detailed discussion of each level of the allocation process is presented below. Federal Allocation to States LIHTCs are first allocated to each state according to its population. In 2018, states were originally scheduled to receive a LIHTC allocation of $ per person, with a minimum small population state allocation of $2,765, The 2018 Consolidated Appropriations Act ( 115-141) increased the amount of credits states will receive by through 2021. The state allocation limits do not apply to the 4% credits which are automatically packaged with tax-exempt bond financed The administration of the tax credit program is typically carried out by each state s Housing Finance Agency (HFA).
10 State Allocation to Developers State HFAs allocate credits to developers of rental Housing according to federally required, but state created, Qualified Allocation Plans (QAPs). Federal law requires that the QAP give priority to projects that serve the lowest income households and that remain affordable for the longest period of time. Many states have two allocation periods per year. Developers apply for the credits by proposing plans to state agencies. Types of developers include nonprofit organizations, for-profit organizations, joint ventures, partnerships, limited partnerships, trusts, corporations, and limited liability corporations. An allocation to a developer does not imply that all allocated tax credits will be claimed. An allocation simply means tax credits are set aside for a developer. Once a developer receives an allocation it has several years to complete its project.